Charting the Financial Waves: China Funds Naval Expansion via Capital Markets

Ol' Vladimir Ilyich Lenin was the one who coined that line about the capitalists selling his buddies and him the rope with which they would then hang them. 

Well, here we are about 90 years later and it looks like the Chinese Navy is strategically - and rather gleefully - adding a modern addendum to that concept.

China Shipbuilding Industry Co. is raising approximately $1.4 billion through private placements to fund capital investment to meet the Chinese Navy's demand for new warships. The opportunity appears to be oversubscribed as China's desire to expand its influence via a 'blue water' navy is widely understood.

The move is clever at several levels. First, given China's short term budget issues based on slower than expected global growth, this shifts the cost of capital expenditures off of the government balance sheet. Secondly, it makes that shift to Chinese consumers who the government has already been attempting to induce to spend more. Finally, it also induces western financial institutions - which profess to be all about the money - to participate in a strategic initiative to weaken the system from whose protection they benefit and pay for with their own taxes (this presumes, perhaps erroneously that some of them do, in fact, pay some taxes somewhere).

As they are so fond of saying on Wall Street, the trend is your friend. In this case, however, it may well turn out in the long term that the wave is your grave. Hypothetically, of course. JL

Simon Rabinovitch reports in the Financial Times:

Capital markets have funded wars for centuries. Now China's military is turning to the stock market to help propel its ambitious naval expansion plans.

Beijing's military spend, at USD 166 bn last year, is second only to the US. The country has been ramping up its naval prowess amid territorial disputes in the South China Sea and other surrounding waters. But with its largest defence contractors still predominantly state-owned, China wants to push them closer to the private sector and on to public markets to foster their growth.

Launching what it described as the start of a new push to use capital markets to fund China's defence industry, state-controlled China Shipbuilding Industry Co, the country's biggest shipbuilder, said it would raise Rmb8.5bn (USD 1.4bn) through a private placement of shares to buy production facilities and equipment to make warships.

Chinese investors cheered the prospect of being able to invest in their country's military-industrial complex, driving the Shanghai-listed shares of China Shipbuilding up by the daily limit of 10 percent. Shares of other companies expected to benefit, such as Shanghai Zhenhua Heavy Industries, a maker of large steel structures, also surged.

The company itself was quick to tout the lucrative nature of military assets to investors. "This will expand the range of investable assets in our capital market and will allow investors to enjoy the returns generated by high-end military products," it said in a statement to the stock exchange.

Other Chinese defence groups have injected assets in their listed subsidiaries over the past year, but China Shipbuilding's move is one of the biggest to date.

It added: "Given our national strategy to protect our maritime rights, our company's military-related duties will continue to expand quickly. To satisfy the need for the development and manufacture of a new generation of weapons and equipment, we urgently need large-scale technological improvements and need to expand our financing channels."

China has ramped up its military spending since the 1980s, with its official defence budget increasing at a double-digit pace every year but one over the past two decades. China's spending is still less than a quarter of the US, which spent USD 682bn, according to the Stockholm International Peace Research Institute.

In recent years, China has placed extra emphasis on building up its blue-water navy - a force capable of operating far from the country's shores. Mired in territorial disputes in the East China Sea with Japan and in the South China Sea with countries including the Philippines and Vietnam, China has started to deploy naval ships more regularly to patrol what it defines as its sovereign waters. In 2011, China launched its first aircraft carrier, the Liaoning, though it was built on an unfinished hull acquired from Ukraine. Analysts believe it is only a matter of time before China produces its first indigenous carrier.

The China Securities Journal, a leading government-run financial newspaper, said the stock market penetration by companies in China's military industry was very low. While about 80 per cent of the assets of the world's top 100 military companies are publicly listed, only 30 per cent of the assets of China's top 10 military companies have been listed, it said.

For China's beleaguered shipbuilding industry, hit hard by overcapacity and slowing economic growth, the start of more military projects offers some consolation. "Military spending is classic counter-cyclical support in a downturn," said Jon Windham, head of Asia transport research at Barclays. "It's simply a more stable part of the business and one they want to talk about more because the commercial side is in free fall."

China Shipbuilding's private placement structure is complex. It is issuing shares to two sibling companies, Wuchang Shipbuilding and Dalian Shipbuilding, to raise the funds, and is then using that money to acquire some of those two company's military assets. Initially, these assets had been stripped out of the listed company when China Shipbuilding went public.